Commentary on how China and the world are adapting to each other -- or not.

April 19, 2011

Will we listen to Dagong now?

Yesterday Standard & Poor's suggested that it might downgrade the AAA sovereign debt rating of the United States because of the lack of progress in tackling its fiscal problems could have on the economy. For the first time in 70 years, S&P's rating of the US moved from "AAA/stable" to "AAA/negative." American stock markets ended the day down, and pessimism spread across the land.

As a China watcher, the first thought that popped into my mind was about Dagong, the private Chinese credit rating agency that started issuing sovereign debt ratings last year. On July 13, 2010, it issued ratings for 50 countries, and many of its ratings diverged sharply from those of S&P and Moody's (see below). The rating for the US was only AA-/negative, while China was given AA+/stable. Dagong explained that its ratings differed from those of the Big Three (S&P, Moody's, and Fitch) in that its calculations stressed future growth potential and fiscal soundness.

On November 9, 2010, Dagong downgraded the United States a full notch, to A+/negative. Dagong's report came shortly after the Federal Reserve initiated a new round of quantitative easing, which Dagong cited as its rationale. Dagong also put special emphasis on the fact that quantitative easing could lead to dollar depreciation "against the will" of America's creditors. The A+ rating with a negative outlook pushed the US rating below Chile's, though it was still higher than those of Spain, Italy, and Portugal.

For at least the last two years the Big Three have indicated their concerns about the American economy and rising debt levels, but yesterday's adjustment was the first actual step in altering their ratings. At the time of its initial sovereign ratings and the adjustment, observers criticized Dagong as implicitly doing the government's bidding, suggesting it was part of the "China, Inc." machine (the kind of charge lobbed at Huawei). It's not unfair to wonder if the Big Three are moving in Dagong's direction, and if so, should Dagong get more credit -- ha, ha -- than it's received so far.

All signs indicate that no one is paying much attention to Dagong. On the day's their ratings were announced, the Dow Jones Industrial Average was essentially unchanged, and the interest rates for T-bills barely moved. (In fact, the day after the first announcement, in July, T-bill rates dropped a tiny bit.) No earthquake, to say to the least.

And Dagong knows it. Chairman Guan Jianzhong openly scoffed at the S&P announcement as irrelevant and overly generous to the US. In a Wall Street Journal interview he said, "The fundamentals of the U.S. economy do not support AAA ratings. The actual debt repayment ability of the U.S. has already collapsed," he said. It is that type of hyperbole that makes the vast majority of observers shake their head, and it is only because of Dagong's weakness that its chair could feel free to utter such caustic statements. Executives for the Big Three, or any company with serious influence, would be much more cautious.

Although the Chinese government has expressed concern about the US fiscal situation, it was cautious in its response to the S&P announcement, though it did not give the vote of confidence that came from Japan. No one in the Chinese government showed any sympathy for remarks like those of Mr. Guan.

That all said, any disdain for Dagong should not mean the highest respect for the Big Three. Their sovereign downgrades actually typically do lead to massive market shifts; the raters are operating on public information that the rest of the market has already calculated into their analysis. At best, rating agencies reflect broader market sentiments. And it's quite possible the raters more often follow market sentiment. The ratings game is just that, a game whose rules and consequences are still not well understood.

I think it's useful to track the raters, but we'd be wise to take what any of the ratings agencies say with a large grain of salt.